Heterogeneity Bias in the Estimation of the Determinants of Workers’ Compensation Loss Distributions

Abstract

The potential for someone covered by insurance either to have too many accidents, or to have too large a loss, is termed moral hazard in the insurance literature. In a world of perfect information and competitive markets for insurance, there should be no moral hazard with respect to workers’ compensation, since both job risk and risk severity would be observed exactly by the insurer, the employer buying insurance, and the workers receiving the benefits. Moral hazard arises because workers, insureds, and insurers do not have perfect knowledge of what the other parties are always doing. In the absence of moral hazard, an increase in benefits should probably have very little impact on either the frequency or the severity of a claim.